Deutsche Bank Analyst Wary of Car Rental Comeback
Car rental stocks took a particularly big hit from our self-imposed quarantine, like all travel stocks did. They have started to come back, but some remain quite leery.
While people rent cars for other reasons, such as when their car is being repaired, the great majority of rentals happen when people fly to a destination and need a car when they get there. They depend on people flying enough, and while we always do normally, the shockingly high 95% reduction in air travel that we saw hit the airline business also decimated car rental companies.
Given how far these travel related stocks have fallen, this has presented some great opportunities for investors to make much higher returns than we normally would get from stocks. No matter how good an opportunity may be, there will always be doubters, and while we may have good reasons to get in plays like this, it’s still important to consider and address the criticisms of this, to make sure that we really are taking things into consideration enough.
Deutsche Bank analyst Chris Woronka admits that while the resurgence in car rental stocks that we’re seeing lately “absolutely could continue,” it has left him still “questioning the true depth of the buying in what increasingly feels like a capitulation-type short squeeze being exacerbated by high frequency trading programs.”
We’re not sure what depth of buying really means here, but his remark suggests that he expects this resurgence to be more transient in nature due to it being driven too much by short covering, but this is a clearly positive influencer on stock prices once momentum turns, and one of the things in itself that makes these plays so attractive and lucrative when the conditions are right.
We’re also not sure why this would be a concern and something that should increase our delight with these plays, as the effect of short covering can play a substantial role in the recovery of a stock that has been beaten down too much. There is still a lot of short interest in these car rental companies, especially with the two that Woronka is looking at, Hertz and Avis Budget, but this just adds to their potential profitability as they move back up the ladder.
In order to understand this all better, we need to step back and assess what has happened to these companies and their stock during the fall phase in order to better illuminate what to expect as they recover.
At the center of this discussion is the phenomenon of momentum. Momentum plays a huge role in the movement of stocks generally, but especially during crashes. There are two forces at work normally with a stock, the market’s view of the company’s prospects and the weight of changes in demand, the momentum part.
Let’s take a stock like Amazon where the future outlook is seen as bright, and this focus on the future will in itself propel its stock’s price. This causes the price of the stock to rise, people see it doing so well, and then jump in to take advantage of this. All this jumping in further drives demand for it and further drives the stock up.
We are paying more attention to performance these days versus the past, and this is why the force of momentum and its role in the movement of stocks has been increasing so much. The gap in performance between stocks that have good momentum and those which do not is widening, and that’s a good thing for investors as long as they get this. If we instead ignore momentum and just look at one part of this, the company’s future outlook, we are going to only have part of the picture and will be relying on the distortion that this creates to decide.
People are slow to cast off misconceptions though, even when their misconceptions are becoming more and more obvious. Momentum has always played a role in stock prices, it’s just that it’s playing an even bigger role these days, and by choosing to ignore it, we are choosing to ignore the truth and instead try to do well by way of false ideas.
We can break these things down as the expectation of company growth versus expectations of the growth in the stock price. Both of these factors drive stock prices, and it’s certainly important to have both, like with Amazon, a good expectation of their business continuing to grow, but once again, that’s only part of the story.
Our expectation of the future prospects of the stock rather than just the company’s future prospects is an essential distinction because it’s the stock that we are tracking here, not the company. It’s also important to understand that the effects of momentum are independent of the company’s future and therefore aren’t limited by the company’s perceived future, in the way that there may be ceilings on it.
This is where just about everyone gets confused and while there are limits on how much a company’s brighter future will drive stock prices up, momentum does its work outside this model and it simply the willingness to pay more just because people expect the stock to rise.
There would be nothing to stop our desire to run Amazon up to $10,000 a share or more if we choose to do so merely by having the will to do it, and while there are certainly limitations on our will, what stands in the way isn’t future earnings but our beliefs of how far the stock may rise. No one expects Amazon to run up that much anytime soon even though there may be a time where we more than triple from here and break through that.
There are also theoretical limits on a stock price based upon overall demand, even though we never come anywhere close to this. In Amazon’s case, this would be where everyone invests all their money in it and nothing else, where demand becomes exhausted and there’s no one to bid up the stock further. Obviously, this is limited to theory only as we’d never see anything close to this.
What we do instead is have a certain expectation of how far a stock can go and then see more people refrain as the added effect of momentum becomes more expressed. Even though we are only imagining these ceilings and they aren’t actually real, once enough people believe, they become real enough as they cause people to be less willing to pay more and also cause more people to worry and take their profits as their level of comfort decreases inverse to price growth.
All we have to do is look at price to determine the role of everything, as this is where the impact of the total supply and demand for a stock to play out. It’s important to realize though that the last traded price is not a valuation of a stock at present in any way, it’s just now the last two participants valued it, where someone may have sold 100 shares to someone else at a certain price.
On the supply side, only 100 of the millions of shares held in the company have been priced at this level. Last traded price is not where the data lies but is instead just one data point in a series, where the valuation of stocks is a dynamic process that manifests over time incrementally, and this is why they trend incrementally rather than just with larger and more occasional gaps.
Along the way, we have a correlation between price and demand, where demand is more prone to increase as the price rises. Supply also is diminished by this by having people less willing to sell. Amazon has a good day and moves up, people see this, and get more excited to buy it and less inclined to sell it based upon this alone.
How Excessive Downward Momentum Created These Opportunities
The same thing happens when the price goes down, other than it’s the supply side that takes over, where people see the price going down and are more prone to sell, as well as people less inclined to buy. Amazon has a bad day and people see this and less people want to buy it now and more people want to sell it.
In a crash like we recently had, the increase in supply and the decrease in demand that we normally see in a sell-off gets multiplied significantly. This becomes especially not driven by future outlook of anything, not the company nor the stock, as this instead involves a mad scramble to get out. They might serve great food at the restaurant you are sitting at but when it catches fire and the smoke starts to build, you run for the exits as the meal no longer is important.
How good this meal is still out there, but has been relegated to the background now. We still know how great Amazon will be, but when it is burning, we are going to want to escape this for now. The downward momentum creates a gap between where the stock would be valued if not for this downward force, and when the force subsides, the price will rise to fill the gap to the point where the normal valuation currently is without the force of downward momentum.
The fact that we end up overselling stocks relative to their future prospects does not involve an error in valuation, as the only people who would even think such a thing are those who are confused about the effects of downward momentum and pretend that it doesn’t exist. Overselling here is very natural and paints a completely accurate picture of the present forces at work, all this fear, and while this momentum is running, it will take us wherever it wants with no regard to anything else.
Once this momentum shifts, it is at this point that future prospects get back in the game, where we may look at a stock like Amazon and get back to bidding it up based upon these future beliefs about both the stock and the company. We’ve been dropped off considerably lower though and created more room between where we were at in terms of our outlook and have some catching up to do.
In addition, the positive momentum that is being created as we work our way back adds to the magnitude and the acceleration of the rebound. This is a different sort of rebound from stocks that have lost a lot not so much by momentum as by way of a diminished view of the future, because the losses here are more real and durable and there isn’t much if anything to correct.
Our rebounds are of the sweeter kind, where the stocks genuinely have been oversold, not just oversold by way of someone’s distorted view of how they should be valued. When you disagree with the valuation of a stock, you are always wrong because market valuation is a factual matter and you are disagreeing with facts.
The market valued knocking down stocks the way that they did with absolute correctness because this is self-defining. We became afraid, and the price measured the fear which caused it to sell off this much, but when the fear subsides, when this downward momentum shifts, this can create opportunities for short-term price appreciation well in excess of the norm. To think otherwise would be to pretend fear doesn’t move markets.
Technical analysis teaches us that the steeper the decline, the steeper the rebound will be generally, and this is because of this effect of overselling. This only is that noteworthy for investors with the steepest of declines, where the potential for a big rebound goes way up, but we sure had one of these this year, even breaking all-time records for this.
Back when Carl Icahn sold his big stake in Hertz after they shared their intentions to file for bankruptcy, he received less than a dollar per share and the price at that point had settled in at a dollar. We told you that this represented a great opportunity if you were willing to be a little patient with it, and while it did stay down in this doldrum for a week and a half, this patience was soon rewarded.
The way that the Hertz trade has materialized so far shows the importance of paying attention to your trades. It did hit our short-term target of $5, closing at $5.50 on Monday, the stock took a hit on Tuesday when it was learned that the NYSE was planning on delisting it. While the bankruptcy did not scare us, this definitely should, and when this word is even brought up, it’s time to flee, without question.
This is an alarm that everyone needs to heed, and the day to get out of this was Tuesday. Traders with skills would have waited until it finished trying to fill the gap and sell when we moved back down, pocketing an easy 500% in just two weeks. Everyone needed to be clicking the sell button at some point and it did finish over $4, and 400% this quick isn’t too shabby at all.
Hertz showed us why we needed to listen to this, as it finished Wednesday at $2.50 and may be heading lower as this news gets more digested. The reason why we do not want to be hanging on to this anymore even if we think that we’ll be considerably higher down the road is that delisting delivers such a huge blow to a stock’s prospects that we never want to be along for this ride.
Hertz is fighting the ruling and the only way that we want back in this is that if the NYSE can be made to change their mind, and this is the point where we will be free to get things moving ahead more as well as making this ride safe enough.
It is worth noting that even though delisting was a risk here, if a play has enough momentum behind it, it can absorb these risks and still have us making a lot of money at the end of the day. We’ll have to wait for the potential for more, but this still ended up being a nice move even though the worst thing that could have happened from here happened.
We Need to Be Careful to Not Be Too Cautious
Going back to the original call back when it was at $1, this was not a hard call to make when we consider that being closed down essentially, going bankrupt, and seeing a legendary hedge fund manager who owns a third of all shares jumping ship, it just doesn’t get much worse than this. Add in the effect that the downward momentum has played, the oversold part of this, and this being subject to correction once things settle down more, this ended up being a fairly low risk investment that had a lot of upside returns wise.
Avis Budget hasn’t gone bankrupt and their stock did not take anywhere near the hit that Hertz did, and had been running pretty flat for quite a while when we did the Hertz article a couple of weeks ago, their stock started to finally break out over this time. They now have doubled their stock price over the last month even though they are starting to give a little back, which does need to be watched.
Avis Budget actually got even on the year on Monday, even though Woronka wants to cast them in the same boat with Hertz. They are on opposite ends of the spectrum, with one only being down a smidgen in 2020 with the other only trading at a small fraction of the price it started the year. Avis Budget followed the market pretty closely given that the market is also around even for the year, it just that Avis Budget took longer to catch up.
Woronka has no problem recognizing the further potential upside of both of these stocks, but he is put off by the risk he sees of a second wave of COVID-19 hitting us in the fall, and this is why his view is interesting and worth discussing. The news about Hertz’s delisting hadn’t hit yet when he wrote this, so to be fair, we will pretend this hasn’t happened when we look at Woronka’s views. At the time, both stocks did have very good potential upside.
Woronka was plenty worried enough about a second wave though. This should never be about what we are guessing about things like this, and as good or as bad of a guess that he is making, not only guessing that a second wave will hit but it will be dramatic enough to put us back in the grips of fear, we should not be basing our investment decisions on guesses like this.
What we need to be doing instead is trading on facts rather than apparitions or guesses, where if Woronka’s fears do actually materialize and become fact, we can become afraid then, when it would make sense to. If we’re still in the first wave and it has subsided enough to make stocks like this very bullish, we need to trade the wave we are in, one wave at a time.
If this did happen and we did get a notable sell-off, both the actual event and the movement in the price of stocks happen incrementally, as it’s not that we will just wake up one day and see infections explode and stocks hit with a huge gap down.
If you are the sort that simply refuses to trade the facts after a trade is underway, like what just happened to Hertz, and would be willing to take whatever punishment that is dished out if a second wave hits, that may be a different matter, and we now at least have to look at what the probabilities are of this second wave.
This is simply a foolish way to invest though and we don’t want to build in the assumption that we will be willing to foolishly expose ourselves to a lot more risk than we have to in an investment and then say that the risk is too high.
Even if we were limited to deciding if these stocks are worthy in the longer-term come what may, it simply is not reasonable to think that with or without this second wave, such a thing would have enough of an impact on this longer-term value to even care about this. Delisting causes long-term damage, where the damage that Woronka fears is only temporary and just doesn’t play in the long run.
With the way that the first wave has spread, just from this, we can be fairly certain that if a second wave does come, it will be of a lesser magnitude than the first, which the modeling also shows us, even by those who have exaggerated the impact of this so much already.
We got though the first one and were able to get in on the lower levels of the expected revival, offering us some incredible deals, and we should not want to be too cautious here and miss out in the likely event that we are wrong.
This stuff just doesn’t matter and far from his fears giving us pause, we should just be ignoring this at least until we actually see it. We’re not sure what Woronka’s response would be to our wanting to ride this bullish wave as long as it continues, where we can just get out when it ends for any reason, including things like second waves and especially things like plans on being delisted.
The fact that this would be the smarter way to proceed is beyond question though, and we especially do not want to be influenced by things that we could otherwise avoid, such as selling all our stocks if we get a big enough second wave to send stocks reeling again.
There is always risk with investing, and to make the right decisions, we need to both manage these risks and view them in perspective of the potential returns. Getting out if a second wave comes falls under the risk management part, and if you can contain this so that the potential rewards can dwarf it, that’s what you call a very desirable trade.
We need to think these things through enough, not just allow whatever misgivings or fears we have to matter so much to cause us to stop thinking. Travel stocks remain pretty bullish, when we consider their current risk to reward ratio. Tomorrow, things may change, but tomorrow will come soon enough and we will have the opportunity to re-evaluate as needed.
We act in the present though, not in the past or the future, and it might seem to us that we do trade in the present, a more thorough examination of what moves us may teach us a lot about how we both rely on both relying on the past or on future guesses too much. Woronka’s unexamined guess here just doesn’t measure up, and this is a good example of how we need to be careful of not overstating risk and miss out on some real nice gains as a result.
Editor, MarketReview.com
John’s sensible advice on all matters related to personal finance will have you examining your own life and tweaking it to achieve your financial goals better.
Contact John: john@marketreview.com
Topics of interest: News & updates from the Securities and Exchange Commission, Stock Markets, Bonds, Loans & more.